Advanced Financial Accounting-I

CHAPTER ONE
ACCOUNTING FOR INCOME TAXES
 Income tax is type of direct tax levied by a government on
businesses.
 Income tax due in a period is calculated by applying the
applicable tax percentage to the taxable income of the business.
 Income tax is a type of tax that governments impose on income
generated by businesses and individuals within their jurisdiction.
 Income tax is used to fund public services, pay government
obligations, and provide goods for citizens.
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 TAX BASE CONCEPTT
- Tax base refers to the total income (including salary, income
from investments, assets, etc.) that can be taxed by a taxing
authority and is thus used to calculate tax liabilities owed by
the individual or the corporation.
- It serves as a total base on which the tax can be charged.
- A tax base is the total amount of assets or revenue that a
government can tax.
- Tax Base Formula = Tax Liability / Tax Rate
- Mr. Chala , a businesswoman, happened to earn $20000 last
year. Out of this amount, $15000 was subject to tax. Assuming
a tax rate is 10%, Determine tax base

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 Cont’d…
•Solution
•Tax Liability = Tax Base * Tax Rate
•Total income 20,000
•Taxable income 15,000
•Tax rate 10%
•Tax liability 15,000*0.1=1500
•Tax base= Tax Liability / Tax Rate
•Tax base=1500/0.1=15,000

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 MEANING OF DEFERRED TAX

 Deferred tax (DT) refers to the difference between tax

amount arrived at from the book profits recorded by a
company and the taxable income.
 The effect arises when taxes are either not paid or
overpaid.
 Companies calculate book profits using a particular
accounting method; tax authorities charge taxes based on
tax laws, and the two often differ.

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 Cont’d…
Note: Book income is used by companies to report their
income and expenses to shareholders.
 Taxable income is used by businesses to report earnings
and tax liability to tax authorities.
 Deferred tax is the gap between income tax determined
by the company accounting methods and the tax payable
determined by tax authorities.

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 Cont’d…
 Deferred tax arises when there is a difference in the
treatment of income, expenses, assets, and a liability
under the company’s accounting procedure and the tax
provision.
 It is the difference between income tax paid and income
tax accrued. The difference results in a surplus or deficit.

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 TYPES OF DEFERRED TAXES

1. DEFERRED TAX LIABILITIES

 A deferred tax liability is a liability recognized when tax paid
in current period is lower that tax that would be payable if
calculated under accrual basis.
 It arises when tax accounting rules defer recognition of income
or advance recognition of an expense resulting in a decrease in
taxable income in current period that would reverse in future.
 Financial statements are prepared in accordance with
accounting standards but income tax payable is worked out
based on income tax rules of the tax authorities such as IRS.
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 Cont’d…
 Deferred Tax Liabilities is the liability that arises to the
company due to the timing difference between the tax accrual
and the date when the taxes are paid to the tax authorities, i.e.,
taxes get due in one accounting period but are not paid in that
period.
 DTL is the amount of income taxes payable in future periods
due to temporary taxable differences.

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 2. Deferred Tax Asset (DTA)

 A deferred tax asset is an asset to the Company that usually

arises when the Company has overpaid taxes or paid advance
tax.
 Such taxes are recorded as an asset on the balance sheet and
are eventually paid back to the Company or deducted from
future taxes.
 These are created because of the timing difference between the
book and taxable profits.

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 Cont’d…

 Deferred tax asset is an asset recognized when taxable

income and tax paid in current period is higher than the tax
amount worked out based on accrual basis or where loss carry
forward is available.
 Deferred tax asset represents the increase in taxes refundable
(or saved) in future years as a result of deductible temporary
differences existing at the end of the current year.

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 There can be the following scenario of deferred
tax asset:
 If book profit is lesser than taxable profit. Then deferred
tax assets get created.
 If, as per books, there is a loss in accounts, but as per
income tax rules, the company shows a profit, and then
the tax has to be paid and will come under deferred tax
assets that can be used for future year tax payment.

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 RECOGNITION OF DEFERRED TAX
LIABILITIES AND ASSETS
1. Recognition of deferred tax liabilities
 A deferred tax liability represents the increase in taxes payable
in future years as a result of taxable temporary differences
existing at the end of the current year.
 Deferred tax liabilities are recognized for taxable temporary
differences, with some exceptions and
Investments in subsidiaries, branches and associates, and inte
rests in joint
ventures
 Taxable temporary differences are temporary differences that
will result in taxable amounts in determining taxable profit
(tax loss) of future periods when the carrying amount of the
asset or liability is recovered
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or settled.
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 Deferred tax liabilities are typically recognized when:

 The carrying amount of an asset is higher than its tax base, or

 The carrying amount of a liability is lower than its tax base.
Taxable temporary differences arise, and deferred tax liabilities
are recognized, when, for example:

 Reporting entity recognizes receivable and related

revenue which will not be taxable until cash receipt.
 An item of property, plant and equipment (PP&E) is
depreciated faster for tax purposes than for
accounting purposes.
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 Cont’d…
 The identifiable assets acquired in a business combination
are recognized at their fair values in accordance with
IFRS 3 Business Combinations (IFRS 3), but no
equivalent adjustment is made for tax purposes.
 Assets are revalued upwards, but this revaluation does not
affect taxable profit in the current period.

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 Cont’d…
 To illustrate how differences in IFRS and tax rules affect
financial reporting and taxable income, assume that ABC
Company reported revenues of $130,000 and expenses of
$60,000 in each of its first three years of operations.
 For tax purposes (following the tax rules), If ABC company
reported the same expenses to the tax authority in each of
the years But, Assume ABC Company reported taxable
revenues of $100,000 in 2015, $150,000 in 2016, and
$140,000 in 2017
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 Cont’d….
Question 1: Assuming tax rate is 40% shows the income
statement over these three years for Financial Reporting
purpose.
ABC COMPANY.
IFRS REPORTING

2015 2016 2017 Total

Revenues 130,000 130,000 130,000
Expenses 60,000 60,000 60,000
Pretax financial income 70,000 70,000 70,000 210,000
Income tax expense (40%) 28,000 28,000 28,000 84,000

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Question 2 show income statement over these three years
for Tax reporting purpose Solution

ABC COMPANY.
Tax REPORTING
2015 2016 2017 Total

Revenues 100,000 150,000 140,000

Expenses 60,000 60,000 60,000

Taxable income 40,000 90,000 80,000 210,000

Income tax payable (40%) 16,000 36,000 32,000 84,000

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Question 3: Compare Income Tax Expense to Income Taxes
Payable
Income tax expense and income taxes payable differed over
the three years but were equal in total, as shows.
ABC COMPANY
INCOME TAX EXPENSE ANDINCOME TAXES PAYABLE
2015 2016 2017 Total

Income tax expense 28,000 28,000 28,000 84,000

Income payable (40%) 16,000 36,000 32,000 84,000

Difference 12,000 (8,000) (4,000) -

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 Cont’d…
The differences between income tax expense and income
taxes payable in this example arise due to the following
simple reason.
1. For financial reporting, companies use the full accrual
method to report revenues.
2. For tax purposes, they generally use a modified cash
basis.

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 Cont’d…

Year Reporting Requirement

2015 Deferred tax liability account increased to $12,000
2016 Deferred tax liability account reduced by $8,000
2017 Deferred tax liability account reduced by $4,000
 As indicates above, for ABC company the $12,000 ($28,000-
$16,000) difference between income tax expense and income taxes
payable in 2015 reflects taxes that it will pay in future periods.
 This $12,000 difference is often referred to as a deferred tax
amount.
 In this case, it is a deferred tax liability. In cases where taxes will
be lower in the future, ABC Company records a deferred tax asset
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 1.2 Future Taxable and Deductible Amounts
A temporary difference is the difference between the tax basis of
an asset or liability and its reported (carrying or book) amount in the
financial statements that will result in taxable amounts or
deductible amounts in future years.
A temporary difference is the difference between the tax basis and
book basis of an asset or liability, which will result in taxable
amounts or deductible amounts in future years.
 Taxable amounts increase taxable income in future years.
 Deductible amounts decrease taxable income in future years.

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 Cont’d…
In ABC Company’s situation, the only difference between the book
basis and tax basis of the assets and liabilities relates to accounts
receivable that arose from revenue recognized for book purposes.
Example: Assume that ABC Company reports accounts receivable at Br
30,000 in the December 31, 2014. However, the receivables have a zero tax
basis
Per Book 12/31/2014 Per tax basis 12/31/2014
Account receivable Br 30000 Account receivable 0
 Assuming that ABC Company expects to collect Br 20,000 of the

receivables in 2015 and Br10,000 in 2016, this collection results in future

taxable amounts of Br 20,000 in 2015 and Br10,000 in 2016.

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 Cont’d…

Required
1. Compute Deferred tax liability at the end of 2014
2. Income tax expense for 2014
3. Make a necessary journal entry for 2014 end
4. Income tax expense for 2015
5. Make a necessary journal entry for 2015 end
6. Journal entry for 2016

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 Solution
A deferred tax liability represents the increase in taxes payable in
future years as a result of taxable temporary differences existing at
the end of the current year.
1. Computation of Deferred tax liability at the end of 2014
Book basis of A/R Br 30, 000
Tax basis of A/R 0

Cumulative temporary difference 2014 30, 000

Tax Rate 40%
Deferred tax liability at the end of 2014 Br12,000

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 2. Computation of Income tax expense for 2014

Income tax expense = current tax expenses (the amount of

income taxes payable for the period) + current deferred tax
expense.
 Because it is the first year of operations for ABC Company,
there is no deferred tax liability at the beginning of the year.
 ABC Company computes the income tax expense for 2014 as
shown below

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 Cont’d…
Deferred tax liability at end of 2014 Br12,000

Deferred tax liability at beginning of 2014 –0–

Deferred tax expense for 2014 Br 12,000

+ Current tax expense for 2014 (income taxes payable) Br 16,000

Income tax expense (total) for 2014 end Br 28,000
 This computation indicates that income tax expense has two components;
current tax expenses (the amount of income taxes payable for the period) and
deferred tax expense.
 Deferred tax expense is the increase in the deferred tax liability balance from
the beginning to the end of the accounting period.
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 3. Journal entry for 2014 end

Income Tax Expense Br28,000

Income Taxes Payable Br. 16,000

Deferred Tax Liabilityof Income tax expense

4. Computation 12,000
for 2015
 At the end of 2015 (the second year), the difference between
the book basis and the tax basis of the accounts receivable is
Br10, 000

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 Cont’d…
 ABC company multiplies this difference by the applicable tax rate
to arrive at the deferred tax liability of Br 4,000 (Br 10,000 x 40%),
which it reports at the end of 2015.
 Income taxes payable for 2015 is Br 36,000.
Deferred tax liability at end of 2015 Br 4,000

Deferred tax liability at beginning of 2015 12,000

Deferred tax expense (benefit) for 2015 (8,000)

Current tax expense for 2015 (income taxes payable) 36,000

Income tax expense (total) for 2015 end Br 28,000

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 5. Journal entry for 2015 end

ABC Company records income tax expense, the change in the

deferred tax liability, and income taxes payable for 2015 as
follows.
Income Tax Expense 28,000
Deferred Tax Liability 8,000
Income Taxes Payable 36,000
 The entry to record income taxes at the end of 2016 reduces
the Deferred Tax Liability by Br 4,000.
 The Deferred Tax Liability account appears as follows at the
end of 2016.

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 6. Journal entry for 2016

Deferred tax liability for2015 Br 8000

Deferred tax liability for2016 Br 4000
Deferred tax liability for 2014 Br 12,000
Deferred tax liability
2015 Br 8000 2014 Br 12000
2016 4000
- 0-
 The Deferred Tax Liability account has a zero
balance at the end of 2016

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 RECOGNITION OF DEFERRED TAX ASSETS

Deferred tax assets are typically recognized when:

a) The carrying amount of an asset is lower than its tax base, or
b) The carrying amount of a liability is higher than its tax base.
•Deductible temporary differences arise and deferred tax assets
are recognized, when, for example:
 a provision is recognized under IAS 37 Provisions, Contingent
Liabilities and Contingent Assets which will be tax deductible
in future periods when actual cash outflow takes place

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 Cont’d…
 Liabilities for long-term employee benefits are recognized under IAS 19

Employee Benefits which will be tax deductible in future periods when

actual cash outflow takes place
 Research and development costs are recognized as an expense in

determining accounting profit in the period in which they are incurred but
may not be permitted as a deduction in determining taxable profit until a
later period.
 The identifiable liabilities assumed in a business combination are

recognized at their fair values in accordance with IFRS 3, but no equivalent

adjustment is made for tax purposes
 Assets are revalued downwards or impaired, but this does not affect taxable

profit in the current period

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 Illustration
 Hunt Company has revenues of $900,000 for both 2019 and
2020.
 It also has operating expenses of $400,000 for each of these
years.
 In addition, Hunt accrues a loss and related liability of $50,000
for financial reporting purposes because of pending litigation.
 Hunt cannot deduct this amount for tax purposes until it pays
the liability, expected in 2020.

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 Cont’d…
 As a result, a deductible amount will occur in 2020 when Hunt
settles the liability, causing taxable income to be lower than
pretax financial information. Assuming tax rate is 40%.
Required:
a) Shows the IFRS reporting and tax reporting over the two
years
b) Compute Deferred Tax Asset, End of 2019
c) Compute and Record income tax expense for 2019
d) Compute and Record income tax expense for 2020

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Solution a

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 Solution B

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 Solution C

Prepare the entry at the end of 2019 to record income taxes

Income Tax Expense 180,000

Deferred Tax Asset 20,000

Income Taxes Payable 200,000

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 Solution D

Prepare the entry at the end of 2020 to record income taxes.

Income Tax Expense 200,000

Deferred Tax Asset 20,000

Income Taxes Payable 180,000

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 FUTURE TAXABLE TEMPORARY DIFFERENCES

 Temporary difference is differences between the carrying

amount of an asset or liability in the statement of financial
position and its tax bases.
 Taxable temporary is a temporary difference that will
result in taxable amounts in determining taxable profit (tax
loss) of future periods when the carrying amount of the
asset or liability is recovered or settled.
 Deductible temporary difference is the temporary
differences that will result in amounts that are
deductible in determining taxable profit (tax loss) of
future periods when the carrying amount of the asset
or liability is recovered or settled.
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 Cont’d…
Taxable temporary differences give rise to
recording deferred tax liabilities.
Deductible temporary differences give rise to
recording deferred tax assets.
ACCOUNTING FOR NET OPERATING LOSS (NOL)
Net operating loss is the operating loss i.e., the expenses
in a period that are more than that of the revenues for
that company in a specific period, which goes into the
accounting books in the period where the company has
allowable tax deductions which are greater than the
current taxable income.
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 Cont’d…
 Net operating losses ("NOL") are a tax credit created.
 NOL can be used to offset positive taxable income,
reducing cash taxes payable.
 A net operating loss (NOL) for income tax purposes is
when a company’s allowable deductions exceed the
taxable income in a tax period
 When there is NOL the company to use the loss to
reduce previous years’ taxes or to carry it forward to
offset future years’ profits.
 It is a benefit that helps reduce the tax liability of the
business.

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 Most Common Reason for Net Operating Loss
when companies are in their start-up phase.
 When companies report an NOL, three common things
can happen:
1. The company does not owe any taxes for the current
period;
2. The company can get a refund for previously paid taxes;
and
3. The company can carry forward its business losses to
lower future taxable income

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 CARRY BACKS & CARRY FORWARDS OF NET
OPERATING LOSS
1. First, set off the NOL by carrying it back to the
preceding 2 years to recover past taxes paid, . If any
losses are still available for set-off then,
2. Set off the NOL in next year and carry forward it for
the next 20 years
3. Any remaining NOL expires after 20 years and has no
value.
4. NOL carried forward are recorded on the balance sheet
as deferred tax assets ("DTA").
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 Cont’d…

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 LOSS CARRY BACK EXAMPLE

 To illustrate the accounting procedures for a net

operating loss carry back, assume that Groh Inc. has no
temporary or permanent differences. Groh experiences
the following.
Year Taxable Income or Loss Tax Rate Tax Tax paid
Paid
2011 50,000 35% 17,500
2012 100,000 30% 30,000
2013 200,000 40% 80,000
2014 (500,000) - 0

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 Required
1. Compute and record Income-tax refund receivable
2. Compute and records the tax effect carry forward as a
deferred tax asset assuming that the enacted future tax
rate is 40 percent.
3. How many Net losses would be forwarded?

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 Disclosure of Income tax related Financial Statement Presentations

a) Balance Sheet
• Deferred tax accounts are reported on the balance sheet as
assets and liabilities. Companies should classify these
accounts as a net current amount and a net noncurrent
amount.
b) Income Statement
• Companies should allocate income tax expense (or benefit) to
continuing operations, discontinued operations, extraordinary
items, and prior period adjustments.
• This approach is referred to as intra period tax allocation.

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 Cont’d…
 In addition, companies should disclose the significant components of
income tax expense attributable to continuing operations:
 Current tax expense or benefit.
 Deferred tax expense or benefit, exclusive of other components listed
below.
 Investment tax credits.
 Government grants (if recognized as a reduction of income tax expense).
 The benefits of operating loss carry forwards (resulting in a reduction of
income tax expense).
 Adjustments of a deferred tax liability or asset for enacted changes in tax
laws or rates or a change in the tax status of a company.
 Adjustments of the beginning-of-the-year balance of a valuation allowance
because of a change in circumstances that causes a change in judgment
about the reliability of the related deferred tax asset in future years.

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 Taxes Which Are Not Included Under Income
Tax
 The following are types of taxes that would not be accounted for as
income tax because they are not based on taxable profits:
 Sales taxes, because they are based on sales value (a gross amount)
rather than on taxable profits (example tax based on total sales value
from sale of alcohol or cigarettes).
 Consumption taxes such as value added tax (VAT), or goods and
services tax (GST), which are taxes levied on any value that is added
to a product.
 Some production taxes may not meet the definition of income tax
depending upon the specific terms (example a tax imposed on
mining companies for each unit mined (based on an individual item)).
 Taxes payable on employee benefits paid (example social security
taxes payable based on a percentage of employee’s wages).
 Stamp duty, a form of tax that is levied on documents.
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 End of Chapter One !

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 CHAPTER TWO
ACCOUNTING FOR SHARE BASED PAYMENT (IFRS 2)

• IFRS 2 defined as ‘share-based payment is an agreement

between the entity (or another group entity or any shareholder of
any group entity) and another party, including an employee that
entitles the other party to receive:
• Cash or other assets of the entity for amounts that are based on
the price (or value) of equity instruments (including shares or
share options) of the entity or another group entity; or
• Equity instruments (including shares or share options, share
appreciation rights) of the entity or another group entity
provided that the specified vesting conditions are met.
 CONCEPT OF VESTING CONDITIONS
• Schemes often contain conditions which must be met before
there is entitlement to the shares is called Vesting conditions..
• ‘Vesting conditions’ determine whether the entity receives the
required services from the counterparty.
• Vesting conditions are subdivided into
1. service conditions and
2. performance conditions
 Measurement and Recognitions

• If the share-based payments vest immediately,

 The employee is not required to complete a specified period
of service before becoming unconditionally entitled to those
share-based payments.
 The entity shall recognize the services received in full, with a
corresponding increase in equity or liabilities.
• If the share-based payments do not vest immediately,
 The employee completes a specified period of service
 The entity shall account for those services as they are
rendered by the employee during the vesting period, with a
corresponding increase in equity or liabilities.
 Basic recognition principles
 Goods acquired in a share-based payment transaction are
recognized when the entity obtains control of the goods.
 Services are recognized as the services are received.
 The ‘credit side’ of the entry is recognized in equity for an
equity-settled share-based payment transaction or as
a liability for a cash-settled share-based payment
transaction.
 The debit side is recognized as an expense, unless it qualifies
for recognition as an asset under other accounting standards
(e.g., shares issued to purchase property, plant and equipment
recognized under IAS 16 Property, Plant and Equipment).
 categories of share-based payment transactions.

• In its scope of IFRS 2, there are three main categories of

share-based payment transactions.
1. Equity-settled
2. Cash-settled
3. Alternatives whether the entity settles the transaction in
cash or by issuing equity instruments
 Equity-settled share-based payment transactions

• An entity must always recognize an equity-settled share-based

payment transaction in its books if it receives the goods or
services
For equity-settled transactions
• Employee services are recognized as expenses, unless they
qualify for recognition as assets, with a corresponding increase
in equity.
• The fair value of the share-based payment, determined at the
grant date, should be expensed over the vesting period from the
service commencement date until vesting date.
 Cont’d…
• For transactions with employees (including others
providing similar services), the fair value of the equity
instruments shall be measured at the grant date
• For transactions with parties other than employees, the
measurement date is the date when the entity obtains the
goods or the counterparty renders service.
• The grant-date fair value is not adjusted for subsequent
changes in the fair value of the equity instruments and
differences between the estimated and actual outcome of
market or non-vesting conditions.

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 Share based payment transaction with no
vesting conditions, Qualified an Asset
Example2: Entity ABC purchased 100 computers for its call
centre in exchange for issuing 20,000 of its ordinary shares.
The cash selling price for each computer is Br 500 and the
shares have a par value of birr 1.
The entity determines that the selling price, which is from an
independent vendor in an arm’s length transaction, is the best
measure of the fair value of the computers.
Consequently, Entity ABC accounts for the transaction as
follows:
 Cont’d…
Property, plant and equipment-computers Br 50,000
Ordinary share capital 20,000
Share premium account 30,000
To recognize the receipt of equipment in exchange for the
issue of 20,000 Entity ABC ordinary shares
Example2. Entity ABC contracted a consultant to advice on
a new marketing campaign. The consultant agreed to
accept ordinary shares of Entity ABC as payment for his
services

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 Cont’d…
 The consultant advice had an invoice price of Br 3,000 and
Entity ABC issued 100 ordinary shares with a par value of
Br10 each.
 The entity determines that the invoice value of the consultant
fees is the best estimate of the fair value of the marketing
advice.
 Consequently, Entity ABC accounts for the transaction as
follow
Marketing expense Br 3,000
Ordinary share capital 1,000
Share premium account 2,000
To recognize the receipt of marketing advice in exchange for the
issue of 100 Entity ABC ordinary shares
 Measurement When There Are Service
Vesting Conditions
• Example1 Entity ABC grants 100 share options to each of its
500 employees. Each grant is conditional upon the employee
working for the entity over the next three years (i,e the vesting
condition is a service condition of three years). The entity
estimates that, on the date of grant, the fair value of each share
option is Br15; the fair value of Br15 is measured as though
there is no service condition. On the basis of a weighted-
average probability, the entity estimates that 20% of employees
will leave during the three-year period and therefore forfeit
their rights to the share options.
• Required: makes the necessary entries in the years during
the vesting period, for services received as consideration for
the share options
 Solution
Year 1 Staff costs Br 200,000
Equity Br 200,000
Calculation: 50,000 options granted × 80% = 40,000 options expected to vest.
40,000 × Br15 grant date fair value of each option × 1/3 of vesting period elapsed
= Br 200,000 recognized in Year 1.

Year 2 Staff costs Br 200,000

Equity Br 200,000
Calculation: 50,000 × 80% = 40,000 options expected to vest. 40,000 × Br15 ×
2/3 -Br200, 000 = Br 200,000 recognized in Year 2.
Cumulative expense at the end of Year 2 is Br 400,000 (Br 200,000 recognized in
Year 1 and Br 200,000 recognized in Year 2).

Year Staff costs Br 200,000

Equity Br 200,000
Calculation: 40,000 × Br15 × 3/3 = Br 600,000 -200,000 recognized in Year 2 – Br 200,000
recognized in Year 1 = Br 200,000 recognized in Year 3
 Example 2
• The facts are the same as in Example above. However, in this
example not everything turns out exactly as expected. In particular:
• At the end of Year 1 the entity revises its estimate of total employee
departures over the three-year period from 20% (100 employees) to
15% (75 employees).
• At the end of Year 2 the entity revises its estimate of total employee
departures over the three-year period from 15% to 12% (60
employees).
• During Year 3, a total of 57 employees forfeited their rights to the
share options during the three-year period, and a total of 44,300
share options (443 employees × 100 options per employee) vested at
the end of Year 3.
Required: Make a necessary journal entries
 Solution
Year 1 Staff costs Br 212,500
Equity Br 212,500
Calculation: 50,000 options granted × 85% = 42,500 options expected to vest.
42,500 × Br15 grant date fair value of each option × 1/3 of vesting period elapsed
= Br 212,500 recognized in Year 1.
Year 2 Staff costs Br 227,500
Equity Br 227,500
Calculation: 50,000 options granted × 88% = 44,000 options expected to vest.
44,000 × Br15 grant date fair value of each option × 2/3 of vesting period elapsed
= Br 440,000 recognized cumulatively to the end of Year 2. Br 440,000 - 212,500
recognized in Year 1 = Br 227,500 recognized in Year 2.
Year 3 Staff costs Br 224,500
Equity Br 224,500
Calculation: 44,300 options vested × Br15 grant date fair value of each option ×
3/3 of vesting period elapsed = Br 664,500 recognized cumulatively to the end of
Year 3. Br 664,500 less Br 227,500 recognized in Year 2 less Br 212,500
recognized in Year 1 = Br 224,500 recognized in Year 3.
 Cash-Settled Share-Based Payment Transactions

• A cash-settled share-based payment transaction is a share-

based payment transaction in which the entity acquires
goods or services by incurring a liability to transfer cash or
other assets to the supplier of those goods or services for
amounts that are based on the price (or value) of equity
instruments (including shares or share options) of the
entity.
• The main difference is that fair value recognized as a credit
to equity for equity-settled share-based payments is set at
grant date and not changed, whereas the cash-settled share-
based payment liability (credit entry) is continually
updated to fair value at each reporting date until the
liability is settled
 Cont…
• For cash-settled share-based payment transactions,
• An entity recognizes a cost and a corresponding liability.
• The liability has to be measured at each reporting date until it is settled; the
change in the fair value of the liability is recognized in profit or loss for the
period.
• The grant-date fair value of the liability is recognized over the vesting
period.
• The grant-date fair value of the liability is capitalized if the services
received qualify for asset recognition.
• Re measurements during the vesting period are recognized immediately to
the extent that they relate to past services, and recognized over the
remaining vesting period to the extent that they relate to future services.
• Re measurements of the liability are recognized in profit or loss.
 Example
On 1 January Year 1, Company B grants one SAR to each of its 100 employees,
subject to a three-year service condition. If the service condition is met, then
the SAR will be settled in cash on 29 January Year 4. The employees will
receive the intrinsic value of the SAR at settlement date – i.e. any increase in
the share price between grant date and 29 January Year 4 At grant date and
throughout the vesting period, B expects all employees to remain in service
with B and they eventually do. The fair value of the SARs develops as follows.

Fair Value
January Year 1 (Grant date) 9
31 December Year 1 12
31 December Year 2 13.5
31 December Year 3 (vesting date) 15
29 January Year 4 (settlement date) 14
 Required: Make necessary Journal entry

• Year 1
Expenses 300
Liability 300
• To recognize services received in Year 1(100 *9*1/3) recognized over the vesting period.
Expenses 100
Liability 100
• To recognize re measurement of 300 (100 x (12 - 9))*1/3
Year 2
Expenses 300
Liability 300
• To recognize services received in Year 2 (1/3 x 900
Expenses 20 0
Liability 200
• To recognize re measurement of 450 (100 x (13.5 - 9))*1/2, less previously recognized re measurement of 100
 Cont…
• Year 3
Expenses 300
Liability 300

• To recognize services received in Year 3 (1/3 x 900

Expenses 300

Liability 300
• To recognize 3/3 of re measurement of 600 (100 x 15 - 9)*3/3, less previously
recognized re measurement of 100-200
• Year 4
Liability 1400
Cash 1400
 Share-Based Payment Transactions with Equity/ Cash Alternatives

• A share-based payment transaction in which the

counterparty (e.g. an employee) has a choice of
settlement is a compound financial instrument that
includes a liability component and an equity
component.
• The entity measures the fair value of the liability
component first, which equals the fair value of the cash
alternative. The entity accounts for that component by
applying the requirements for cash-settled share-based
payments – i.e. the liability component is re measured
until settlement date.
 Cont…
• The value of the equity component takes into account
that the counterparty forfeits the cash alternative. The
entity accounts for the equity component, if there is
any, by applying the requirements for equity-settled
share-based payments – i.e. the equity component is
not re measured after the grant date.
• If the counterparty chooses equity settlement, then the
liability is reclassified to equity. If the counterparty
chooses cash settlement, then the equity component
remains in equity.
 Example
• On 1 January Year 1, Company E grants a share-based payment to its CEO, subject to a
two-year service condition. After the service period, the CEO is entitled to either:
• 1,000 SARs settled in cash at their intrinsic value at settlement date; or 1,200 share
options, to be exercised at an exercise price that equals the share price at grant date
– i.e. 1
• The rights can be exercised only on 29 January Year 3. The CEO is expected to fulfill
the service condition, and ultimately does.
• The values of the individual SARs and the individual share options are always the
same and develop as follows.
January Year 1 1.00 Fair value
31 December Year 1 1.30 Fair value
31 December Year 2 1.40 Fair value
29 January Year 3 1.35 Fair value
• The fair value of the liability component at grant date is 1,000 (1,000 x 1). The fair
value of the equity alternative is 1,200 (1,200 x 1). Therefore, the grant-date fair value
of the equity component is 200 (1,200 - 1,000).
• Required: Make Necessary Journal entry
 Solution
• 1st determine fair value of liability components
= 1,000 (1,000 x 1).
• 2nd Determine fair value of the equity
alternative = 1,200 (1,200 x 1).
• Then, the grant-date fair value of the equity
component = 200 (1, For equity components
apply requirements of equity settled (1,200 -
1,000).
 Cont…
Year 1
Expenses 100
Equity 100
To recognize expense related to equity component (200 x 1/2
Expenses 650
Liability 650
To recognize expense related to liability component (1,000 x 1.30 x 1/2).
Year 2
Expenses 100
Equity 100
To recognize expenses related to equity component 200*2/2-100 )
Expenses 750
Liability 750
To recognize expenses related to liability component (1,000 x 1.40 - 650).
Year 3
Expenses 50
Equity 50
To re measure liability component to its fair value at settlement date (1,350 - 1,400
Cumulative effect before settlement
Cont….
Expenses 1,550
Equity 200
Liability 1,350
Settlement of the share-based payment is recognized as follows
under the two possible settlement scenarios
Scenario A – Employee chooses cash settlement
Liability 1350
Cash 1350
To recognize settlement of liability
Scenario B – Employee chooses equity settlement
Liability 1350
Equity 1350
To recognize reclassification of liability to equity